Regulators, she said, must examine whether prudential standards contributed to the contraction and whether the standards reflect the actual risks involved.
“In part, this results from over calibration of the capital treatment for these activities, resulting in requirements that are both disproportionate to risk and that make mortgage activities too costly for banks to engage,” Bowman said. “I see a path forward that incorporates both renewed bank participation in the mortgage market and a safe and sound banking system.”
Capital rules, market consequences
Bowman’s speech focused heavily on 2013 changes to the capital treatment of mortgage servicing rights (MSRs).
These revisions increased risk weights for many institutions and imposed a deduction threshold that applied extra penalties once MSRs exceeded a set percentage of capital. She acknowledged the original rationale behind the rules.
“At the time, regulators tightened MSR capital treatment for sound reasons,” Bowman said. “MSR valuations can be challenging to calculate because they are not based on transaction prices in liquid markets. Instead, they are derived from models that depend on subjective assumptions about mortgage prepayment and the likelihood of default.
“This makes the valuations volatile, especially during interest rate swings, and we have observed that during periods of high defaults, some MSR markets can experience stress or seize up.”
Still, she cautioned that the pendulum may have swung too far.
“These are legitimate concerns, and I want to be clear that holding MSRs is not the right choice for every bank,” Bowman added. “Successfully managing the volatility in MSR valuations as interest rates change requires sophisticated hedging capabilities or an effective borrower retention strategy during refinancing waves.”
Over time, Bowman said, regulators have gained greater insight into how capital treatment influences pricing and participation decisions.
Because banks securitize a large share of loans to low- and moderate-income borrowers, she suggested the MSR framework may have implications for mortgage availability and affordability.
She also raised concerns that uniform risk weights for mortgages — regardless of loan-to-value (LTV) ratios — fail to reflect differences in default probability and loss severity.
“In light of these considerations, I am open to revisiting whether the capital treatment of MSRs and mortgages is appropriately calibrated and is commensurate with the risks,” Bowman said.
Basel changes on the horizon
Bowman outlined two forthcoming proposals within the Basel capital framework.
The first would eliminate the requirement to deduct mortgage servicing assets from regulatory capital while retaining a 250% risk weight, with regulators seeking comment on whether that level is appropriate.
The second would introduce greater risk sensitivity for residential mortgage…
Read More: Basel capital rules may be revised to boost bank mortgage lending
